A big rally for stocks in 2013?

The Elbert Files

It was one of those cold days between Christmas and New Year’s when I ran into my old friend K.C., striding along Grand Avenue in his four-buckle galoshes.

“Are you ready for some good news?” he asked.

“Sure,” I said, “anything to take my mind off football. I’m 0 for 5 in my bowl picks, so far.”

“You know that friend of yours, the economist who used to live here?”

“You mean Jim Paulsen,” I said. Paulsen had worked in Des Moines before joining Wells Capital Management in Minneapolis as chief investment strategist.

“Well,” said K.C., “he says the stock market will go nuts this year.”

“Are you sure?” I asked. “Jim is usually a pretty cautious guy.”

“He said it, all right,” K.C. replied. “You can look it up.”

I did when I got home.

Paulsen’s Dec. 27 newsletter is, indeed, one of the most optimistic projections I’ve read in years. He predicts the Standard & Poor’s 500 index will gain 15-20 percent this year.

Such gains would easily carry it beyond the all-time S&P high of 1,565, which is 9.7 percent higher than the 2012 close. In fact, the high end of Paulsen’s range would push the index above 1,700.

Once the S&P index tops its 2007 record high, Paulsen wrote, the focus of investors and analysts will change, and change quickly.

Instead of minimizing risk exposure, as they do now, he said, investors and analysts “will begin to ask whether most are missing out by being too conservative.”

When that conversation begins, he said, look for a quick reversal of the trend that’s been in place the last four years, where investors have liquidated stock mutual funds and put their money into bond funds.

If Paulsen is correct, it’s the bond funds that will be hammered in 2013, because once investors realize they are missing out on double-digit stock returns, many will decide to exit bond funds that are barely keeping pace with inflation.

One key reason that investors have not made that leap already is confidence, Paulsen said. After all, the S&P 500 has already posted double-digit annual returns of 13 to 20 percent in three of the last four years.

Up until now, he said, investors have been held in place by fear of everything from massive bank failures to municipal bond and sovereign debt defaults, another housing market collapse, the “fiscal cliff,” China, you name it.

Now, four years after waiting in vain for Armageddon, investors and businesses are becoming restless and deciding it’s time to move on, to once again take a longer view.

As investors lengthen their investment horizons, they will arrive at higher valuations for stocks, Paulsen predicted.

It’s happened before, he said.

Twice in the post-World War II era, there has been a significant lag in economic cycles between the time when corporate earnings rebounded and when that rebound was translated into higher values for shareholders.

Earnings surges of the late 1940s, and again during the 1970s, were accompanied by basically flat share growth but were eventually followed by bull markets, he said.

Two similar surges in corporate earnings since 2000 were also accompanied by sideways stock markets.

So, Paulsen argues, barring renewed fears about a fiscal Armageddon, 2013 will be the year when investors come off the sidelines and convert earnings growth into higher stock prices.

“If he’s right,” I told K.C. as he headed west on an icy sidewalk, “I might make enough money in the market this year to cover my football pool losses.”